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Market taking a breather after rally driven by strong retail sales and dollar weakness

The market seems to be taking a breather after yesterday’s rally, fuelled by stronger-than-expected retail sales data (boosted by strength in the auto industry, offset partially by weakness in housing-related sectors) and dollar weakness.  Despite signs of an economic recovery by the former, the latter reflected expectations of continued low interest rates.  The reaction followed Bernanke’s warnings of a weak recovery, which gave confidence to investors that the Fed will keep interest rates low. 

Low interest rates can give more time for the financial system to heal, but they also result in a weaker dollar because of excess liquidity, a larger supply of dollars in the market, and future inflationary pressures.  The weaker dollar in turn can help the economy by making US exports cheaper.  The paradox is that the market rallied on news that the economy is doing worse, simply because worse economic data mean that interest rates will stay low.  One explanation of this market reaction is that investors already know that the economy is doing poorly, but they lack the confidence that the government knows that and that it understands the importance of extending low interest rates.

Credit reporting agency TransUnion reported that a record 6.25% of all US mortgages were 60 days or more past due as of Sept 30.  Getting 2 months behind on mortgage payments is a significant milestone towards going into foreclosure proceedings, i.e., there is a high “roll-rate” forward to foreclosures from that bucket.  The silver lining in the report was that the 60+ day delinquency rate increased at a slower pace than it has been rising in the past few quarters, growing at 7.6% from June, which showed an 11.3% rise since March, which in turn jumped 14% since December. 

The slowdown is good news, but the fact that delinquencies are still increasing indicates that there could be a lot more pain in mortgages going forward.  For one thing, banks have been telling their investors that they will stop building reserves in the next couple of quarters; however, if delinquencies keep rising, they cannot stop building reserves.  This delinquency rate will be a key metric to follow before an investor can believe banks’ optimism.

Disclosure: No positions